Magazine

Stocks By The Barrel: Sizing Up The Oil Patch

February 27, 2005

Most of the world's energy titans by now have reported blowout 2004 profits. At ExxonMobil (XOM), net was up 18%. At BP (BP), it was up 26%. Even net of troubled Royal Dutch/Shell (RD) was up 48%. With crude prices still riding high, they're all looking forward to more bounty. But if crude supplies stay tight, will these be the best oil stocks to hold?

Maybe not. Usually, investors' first focus is on sales and earnings. But unless substantial new supplies of crude oil are found to meet growth in demand from China and South Asia, investors may start to pay less heed to income statements and more to balance sheets. Or, more specifically, to every energy company's chief asset: proved reserves of oil and natural gas, the source from which future profits will flow. Veteran energy analyst Charles Maxwell of Weeden & Co. suggested to me recently that when investors shift their gaze from profits to reserves, "a new growth elite among energy stocks will emerge."

Plenty of people on Wall Street and in the industry disagree with Maxwell's long-held and widely known view that non-OPEC oil production is destined to peak around 2010. The chance he is right, however, can't be ignored. Which raises a question: If investors begin focusing more on energy companies' reserves, which stocks would benefit?

TO TRY TO ANSWER THAT, I adapted and updated a ranking that Maxwell keeps of major energy stocks by proved reserves and market values. Instead of using stock market capitalization, as Maxwell does, I substituted total enterprise value, to capture each company's net indebtedness along with its equity value. Next, I surveyed 14 companies to collect their latest estimates of proved reserves. (For those, such as ExxonMobil, that won't report their yearend 2004 reserves until March, I used the latest available data.) Finally, following Maxwell's method, I worked a ratio to see how many barrels of oil-equivalent (a unit that equates natural gas to crude oil) each $100 investment in one of these stocks buys.

The results are in the table. Royal Dutch/Shell recently cut its estimate of proved reserves. Yet its stock is nearing an all-time high. That's a double whammy by this measure -- so $100 invested in Royal Dutch/Shell buys just 5.8 barrels of oil-equivalent. Two leading peers, BP and ExxonMobil, also are trading near their highs, so they fare only a bit better. A sign of the times: ExxonMobil is so prized on Wall Street that it's set to overtake General Electric (GE) as No. 1 in market cap.

What stands out as a potential value? Two names that, despite being traded on the New York Stock Exchange, are much less familiar to U.S. investors: Brazil's Petr?leo Brasileiro (PBR) (Petrobr?s), which has 18.6 barrels of oil-equivalent per $100 investment, and Repsol YPF (REP) of Spain, with 12.3 barrels. Buoyed last year by discoveries offshore, Petrobr?s added 1.3 barrels to proved reserves for each barrel that it produced. That's in contrast to, say, BP, which replaced each barrel produced with less than 0.9 barrels. Repsol is poised to release its 2004 reserves data on Feb. 22.

This ranking doesn't account for the companies' many other strengths and weaknesses. ExxonMobil's AAA credit rating, for example, lowers its cost of capital. Or, as Royal Dutch/Shell's series of downward restatements of reserves show, assets can dry up fast. Just the same, if you believe, as I do, that barrels of oil are only becoming more precious, so will the stocks of those who have them.

Corrections and Clarifications

"Stocks by the barrel: Sizing up the oil patch" (The Barker Portfolio, Feb. 28) should have cited ChevronTexaco, not ExxonMobil, as one of the oil companies that did not plan to report yearend 2004 petroleum reserves before March. ExxonMobil reported its reserves on Feb. 18. Also, the stock prices of ChevronTexaco and ConocoPhillips listed in the accompanying table were transposed.